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Is Natural Gas Making a Comeback?

August 20, 2013

In the past several months natural gas has had a downward trend. The price of natural gas is getting closer to the $3 mark. Despite the sharp fall in natural gas price, it is still much higher than last year’s price that reached at one point $2. Looking forward, will the natural gas market continue to cool down? How the recent developments in this market affect natural gas companies such as of Northeast Utilities System (NYSE:NU)?

Is natural gas’s ETF follows natural gas?

One issue that some investors overlook is that certain ETFs don’t perform as the commodity they follow does. One reason for this discrepancy is roll decay that occurs when there is Contango.

United States Natural Gas (NYSEMKT: UNG) follows the price of short term natural gas futures, which are traded in NYMEX and are mostly September’s contracts. As of August 14th, the fund’s net assets reached $890 million. Is this ETF accurately follows natural gas price?

The chart below shows the developments in the United States Natural Gas and the short term price of natural gas during the year (up to date).

Data Source: EIA

As seen, UNG is correlated with the changes in the price of natural gas. Nonetheless, UNG is still below the price of natural gas. Since the beginning of the year, natural gas rose by 3.5%, while UNG fell by nearly 3%. Thus, if an investor wishes to hedge against the rise of natural gas price; investing in UNG won’t completely hedge against such an occurrence. Keep in mind, investing in an ETF includes management fees – for UNG the fee is 0.6%. This is another factor that will result in even lower return on such an investment.

Let’s turn to the latest developments in the natural gas market to determine where the price of natural gas might be headed.

Demand and supply of natural gas

According to the Energy Information Administration, natural gas consumption in the residential/commercial sector slightly rose in recent weeks. Moreover, consumption in the power sector also grew as utilities companies continue to use natural gas to generate electricity. Therefore, the total demand for natural gas rose in recent weeks. The recent rise in power sector and residential/commercial sector is keeping the total demand rising. This is likely to push back up the price of natural gas.

Despite the recent increase in consumption, the EIA shows that in the power sector during the first five months of 2013 consumption fell by 15.2% compared to the same time frame last year. Conversely, the demand in the residential/commercial sector rose by 21.4% during the first five months of 2013. In total, the demand for natural gas increased by 3.6% up to May 2013.

From the supply standpoint, natural gas production continues to fall. On the other hand, the number of natural gas rigs slightly rose last week and reached 386 by the end of last week. The current number of rigs is still 22% lower than last year’s rig count.

Based on the above, the recovery in the demand for natural gas and the drop in production could eventually result in a rise in the price of natural gas in the near future.

The potential rise in natural gas price and demand in the residential/commercial and power sectors could help pull up the revenues and profit margins of Northeast Utilities System. During the first half of 2013, the company’s natural gas distribution accounted for only 14% of its revenues but it is the second profitable segment with a profit margin of 17%. The most profitable segment the company has is the transmission segment with a profitability of over 60% in the first half of 2013. Most of Northeast Utilities’ revenues still come from the electric segment that accounts for 71% of its total revenues; this segment’s profit margin, however, is low – only 14.1%. But if the natural gas and transmission segments will keep expanding this could result in a higher profit margin. The company’s merger with NSTAR and its ongoing rise in investment in transmission infrastructure helped augment Northeast Utilities’ revenues and profit margin. This trend may persist if the company will keep expanding its operations and the natural gas market conditions will continue to improve.

Liquefied natural gas

During 2013 (up-to-date), shares of Cheniere Energy (NYSEMKT: LNG) jumped by almost 47%. Despite the sharp rise in the company’s stock, it has yet to turn an operating profit in the past several quarters.

Cheniere was the first company to receive an authorization from US Department of Energy to export LNG back in 2011. Since then, however, the DOE didn’t approve any additional LNG projects until May this year; currently more companies and projects including Freeport LNG are on track for selling as much as 5.6 Bcf per day to none free-trade partners with the U.S. The current expectations of Cheniere Energy are to start exporting from train 1 in the Sabine Pass Liquefaction project by 2015. The company continues to issue loans to fund its high capital expenditures. Despite its high debt-to-equity ratio of 15, in May 2013 it was able to secure $5.9 billion loans to finance the costs of the Sabine Pass Liquefaction project. The current low interest rates allowed the company to pay a relatively low rate for these loans. Considering the current low price of natural gas, the new discoveries of natural gas around the world, and the DOE’s decision to approve other LNG facilities, Cheniere Energy investors might not see the high return they will expect to receive.

Finally, LNG exports are likely to sharply rise in the near future, which could also pressure up the price of natural gas in the U.S.

Take away

The natural gas market might start to pick up as the demand for natural gas, mainly in the power sector, continues to slowly rise. LNG exports could eventually positively affect the price of natural gas. Finally, if the price of natural gas will bounce back in the coming months this could positively affect the bottom line of natural gas companies such as Northeast Utilities System.

Disclaimer:The author holds no positions in stocks mentioned and does not plan to initiate positions within 120 hours of the posting of this article. This article is to be used for educational, research and informational purposes only and does not constitute investment advice. There are no guarantees, expressed or implied, of future positive returns in regards to the subject matter contained herein. Understand the risks inherent in investing before making the decision to invest or consult an investment professional for more information. Reasonable due diligence has been performed in regards to the information in this article. However, the author expressly disclaims any liability for accidental omissions of information or errors in fact.